Determinants of non-performing loans: evidence from Euro-area countries

Abstract

The primary objective of this study is to identify the main determinants of non performing loans (NPLs) in the euro-area banking system for the period 1990Q1-2015Q2. The increase in NPLs post- 2007 has put into question the robustness of many European banks and the stability of the whole sector. It still remains a serious challenge, especially in peripheral countries which are hardest hit by the financial crisis.After examining the literature on the reasons for the significant increase of nonperforming loans, we ended up with a series of macro (country-specific) and micro(bank-specific) financial factors. We used data for 138 banks headquartered in 15euro-area countries (taken from Datastream). The econometric estimation of our model with pooled OLS, with fixed effects and with random effects shows that the most significant determinants of NPLs are the ratio of loans-to-deposits, the return on assets, the return on equity, the rate of unemployment, the income tax rate, the output gap and inflation. Our empirical findings confirm the literature regarding the factors that affect non-performing loans. These results are cluster robust to the alternative econometric specifications. The new contribution to the literature that we have attempted here includes the role of the tax on personal income (found to have a significant positive role) and the output gap (found to have a significant negative role). Such findings can be helpful when designing macro-prudential policies.